The effect of corporate taxation on investment

This study estimates the investment, financing, and payout responses to variation in a firm’s effective corporate income tax rate in the United States. I exploit quasi-experimental variation created by the Domestic Production Activities Deduction, a corporate tax expenditure created in 2005. A 1 percentage point reduction in tax rates increases investment by 4.7 percent of installed capital, increases payouts by 0.3 percent of sales, and decreases debt by 5.3 percent of total assets. These estimates suggest that lower corporate tax rates and faster accelerated depreciation each stimulate a similar increase in investment, per dollar in lost revenue.

That is by Eric Ohrn, in the American Economic Journal: Economic Policy.  And from Lu Wang at Bloomberg:

After months of heated debate over whether companies would hand the biggest tax break in three decades back to shareholders or reinvest it in their businesses, there’s finally some hard data.

Among the 130 companies in the S&P 500 that have reported results in this earnings season, capital spending increased by 39 percent, the fastest rate in seven years, data compiled by UBS AG show. Meanwhile, returns to shareholders are growing at a much slower pace, with net buybacks rising 16 percent. Dividends saw an 11 percent boost.

That is hardly conclusive, but…

Comments

'That is hardly conclusive'

Of course it is conclusive in the land of quarterly thinking.

So... tell us how it is in the land of five-year plans?

No idea, I have never lived in such a land. But considering that they seem to have ended up in the dustbin of history, it is obvious that five year plans are a disaster.

Though of course, till now, pretty much only one land has become utterly dominated by quarterly thinking - a shift that seems to have actually happened during my life, providing a bit of contrast between the time when America was famous for its industrial might and ability to carry through a long term project like putting a man on the man, and now.

Strangely, a country like modern Germany seems to be able to avoid both quarterly thinking and five year plans, but America seemingly has little to learn from a country where the federal government has not practiced deficit financing for several years at this point, and where trade balance remains positive.

"... contrast between the time when America was famous for its industrial might [snip] and now." - Erm, it kinda still is: http://www.nationmaster.com/country-info/stats/Industry/Manufacturing-output .

As for Germany, well, I am certainly with you on the deficit financing, but the last few years' surpluses don't add up to the deficit in 2010 alone. Good for Germany if they can keep this up, but I have my doubts. As for positive trade balance - could you explain a) why this is a good thing, and b) if China, Japan, Germany (and EU as a whole), Brazil, and Russia all have positive trade balances, who do you think will have to take the offsetting negative ones? UK and India are not enough. If the US were to start running a positive trade balance, this will make it that much more difficult for Germany to run one.

"... like putting a man on the man..." - I know what you mean, and I know we all make typos, but I laughed.

Yep, amusing typo.

As for industries, I find this sort of information useful (also noting it is VDMA PR too) - 'The major boost to German exports came from America, with an increase of one-fifth. Brazil and Mexico reported significantly overproportional rises. There was also a gratifying performance by the second-most-important machine tool market, the USA, which with growth of likewise one-fifth is precisely in line. “This means the USA’s economy is investing, and we as equipment suppliers are participating in the benefits. Because without machines from abroad, also and especially from Germany, the USA’s industrial sector cannot regain its competitiveness on the global market,” says Heinz-Jürgen Prokop' Call it a non-American perspective of what makes an industrial society notable - that it is able to build the machines it needs for its industries to complete against other industrial societies. Producing a lot of plastic shrink wrap is not the same thing from this perspective. There tends to be a lot of condescension these days on the part of German companies that also work in the U.S., actually, which did not exist a generation ago.

'could you explain a) why this is a good thing, and b) if China, Japan, Germany (and EU as a whole), Brazil, and Russia all have positive trade balances, who do you think will have to take the offsetting negative ones'

This get a bit complicated. First, maybe because I am just old enough to remember another time, when consuming was not the measure that is important when looking at whether a society can meet future challenges. If you look at how the U.S. is starting to suffer surprising shortages in various pharmaceuticals (as often highlighted by Prof. Tabarrok), one can easily see that the problem is much deeper than a single point of failure. The desire to consume remains independent of the ability to produce, and instead of doing the work of increasing production, excuses are sought.

There is the argument that a trade surplus/deficit is an accounting entity, and that perspective is not incorrect if one is an accountant. However, compare the German car industry to the American one, and it is possible to see why it is better to be on the surplus side of the equation. What happens to all the people employed by Daimler in America (think trucks) is decided in Stuttgart - and the people making the drivetrains for Mercedes cars are in Germany, not the U.S. As are the machine tool makers, by and large. Almost as if it is all connected in some mysterious fashion that is not recognized by those saying that Daimler is just another American car company, like Honda, buying parts from American suppliers like Bosch GmbH or Hutchinson SA.

A trade surplus merely means that the country with the surplus has more freedom than the country with the deficit, and more ability to invest in its future by selling products to those requiring them - as noted by that first quote.

This discussion can go on forever, and in a sense, I represent a perspective that has very much faded out in the U.S. as I grew up there. In Germany, such a perspective is considered commonplace - and based on more than a 100 years of industrial history.

But what about Germany's extreme capital account deficit?

What evidence makes you believe this? Poterba and Summers (1995) finds that American and European managers have similar planning horizons. They also provide evidence for longer Japanese planning horizons, but given the performance of the Japanese economy it may be that their investment horizons are too long and therefore they sub-optimally over-invest.

'What evidence makes you believe this?'

The fate of the American car industry since 1995?

A) Very sad for you to think that could serve as the basis for such a belief. That's a stunning admission to me that suggests a complete lack of rationality on your part.

B) That fate being...?

Pundits of all political stripes have all kinds of reasons for the decline in US auto dominance. But I've never heard one argue that it was quarterly thinking!!!! Quite a straw to grasp!

A 1 percentage point reduction in tax rates increases investment by 4.7 percent of installed capital, increases payouts by 0.3 percent of sales, and decreases debt by 5.3 percent of total assets.

The methodology is not spelled out in that quote but it still makes my heart sink. How can we know if it is trustworthy?

However assuming that is a valid finding, the decrease in debt by 5.3 percent is interesting. It suggests to me that a lot of people are trying to reduce their tax burden by pointless investment. If it is investment as actual investment goes up by over 4 percent. Shall we say imaginative accounting? That seems a lot of effort to avoid just 1%.

The whole post had some percentage points floating in space all by themselves. Nearly useless without context. Numbers compared against themselves are almost pointless.

We don't know if 90 cents of every reduced tax dollar was directed to investment, or 5 cents.

Yes. Absolutely.

The Wang article tells us nothing about how the money was divided up, not does it tell us what the bases of the percentages are.

The Ohrn abstract is similar. This percent of that, that percent of this, etc. And what exactly is a "1 percentage point reduction in tax rates?"

Effective rate? Top marginal rate?

Hardly conclusive? Yes. I'd say not at all conclusive, TC's hints notwithstanding.

with net buybacks rising 16 percent.

It seems likely that when corporations buy back stock the shares purchased are primarily those that have been awarded as compensation to management.

It's not that I disagree. Do you have evidence of that?

Even when insiders aren't directly benefited, stock buy-backs are
(artificially?) accretive to all holders' stock market prices.

My antipathy for buy-backs is that free cash flow could be used for dividend payments or productive (investment, pay-down debt, increase staffing/compensation, R&D, etc.) purposes, not monkeying with return on equity ratios, stock prices or backdoor enriching insiders.

Buy-backs are alternatives to dividends. Over the years, some managements favored buy-backs. Neither transaction avoids the double taxation (corporations pay income taxes, dividend recipients pay income taxes, buy-back beneficiaries pay capital gains taxes) crisis.

If short-selling is regulated as unfair and manipulative, so should company stock buybacks.

Is the float shrinking? Or are the buybacks simply buying back some of the shares issued as compensation? I take a dim view of increasing float plus share buybacks. That should be treated harshly by the market, if not regulated.

"My antipathy for buy-backs is that free cash flow could be used for dividend payments "

I was under the impression that the current tax code favors buy backs over dividends. Essentially a buy back increases the value of the stock as much as a dividend would reward the stock owner, but the dividend is immediately taxable.

Fine. But in our case, if we believe current deficits are future tax, this is a transfer.

Are you all ultra-Keynesians now? Stimulate through the top of an economic cycle?

The elephant in the room:

Earlier on Monday the Treasury said net borrowing totaled $488 billion from January through March, a record for that period and about $47 billion more than it had previously estimated, according to a statement released in Washington. The end-of-March cash balance was $290 billion, compared with an initial estimate of $210 billion.

But then, Individuals process small and large numbers differently.

Crickets from the folk who hated stimulus in 2010. Because now a trillion in new debt is a Republican tax cut. For the rich, no less.

Classic.

... what ? -- taxes reduce productivity? (some economist somewhere should write that down)

Exactly. I don’t think The Founder appreciates deviationism, especially if it credits Trump with something positive.

Wonder how Megan likes her new job in the Democracy Dies in Darkness (sic) lair.

Oh jeeze, Lu Wang didn’t read the memo, she is going to lose her job with articles like that. You have to follow Bloomberg policy if you’re going to work at Bloomberg. Talk to McArdle! Meet the quota!

"whether companies would hand the biggest tax break in three decades back to shareholders "

They don't need to hand it back, the shareholders already own it.

I’m always dismayed when economists provide results which are intended to suggest that EACH 1% change provides some particular change. The effect is almost certainly a non linear curve.

Similarly reporting that buybacks haven’t increased percentage wise as much as investment tells us nothing without the base rates. It is easy to imagine cases where a company is woefully underinvesting in capital and dramatically over engaging in buybacks such that a 39% increase in investment and a 16% increase in buybacks would still leave them woefully underinvesting and overbuybacking.

Report the base rates.

A 100% increase in zero is....

Sometimes theory trumps reality, other times reality trumps theory. “If the facts are against you, argue the law. If the law is against you, argue the facts. If the law and the facts are against you, pound the table and yell like hell”. That's Carl Sandburg. Lawyers modify the last admonition to read: if the law and the facts are against you, argue public policy. Ideologues modify the last admonition to read: if the law and the facts are against you, ignore them and promote the ideology.

Does Russia spend as much on the military as the Koch brothers on George Mason University? George Mason University president: "I'm shocked, shocked, to find that academic independence at GMU has been sold for a measly $48 million received over three years! It's worth at least $48 million in a single cash payment". https://www.nytimes.com/2018/05/01/us/koch-george-mason-university.html

Hmmm ... I wonder what the effect of giving $2,000 million to the Clinton Foundation is?

https://www.washingtonpost.com/graphics/politics/clinton-money/

My point is that the president of GMU is either an idiot or a liar. Whether GMU is worth more or less than that of a former president I will leave to markets. You do believe in markets, don't you?

Wouldn’t the increase in capex be due to the temporary full expensing?

We should follow Pat Buchanan's plan to completely eliminate the corporate income tax. The lost revenue ~$500 billion/year could be replaced by tariffs. The terms-of-trade gain would be on the order of $300 billion/year, thus add up to a substantial overall tax cut, despite being revenue neutral, and would probably eliminate the trade deficit.

Tyler, you have my vote. Your ideas regarding taxation make sense.

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